Competition Is on the Decline, and That’s Fueling Inequality

It’s almost a truism among executives that business is more competitive today than in decades past. Technology has lowered barriers to entry; global trade has put companies in competition with rivals across the globe; the list of billion-dollar “unicorn” startups seems to grow longer by the day. But Jason Furman, the chair of the Council of Economic Advisors under President Obama, argues that the problem with the economy isn’t that there’s too much competition; it’s that there’s not enough. In 2015, he and Peter Orszag published a paper suggesting that competition was on the decline, boosting monopoly power for a small number of incumbent firms. That in turn meant higher “rents” — economic parlance for excess profits, above what a company would normally earn in a competitive market.

HBR senior associate editor Walter Frick asked Furman, now a senior fellow at the Peterson Institute for International Economics, to explain why he thinks the economy has become less competitive and how that relates to the rise of inequality between firms and between individuals. Edited excerpts of the conversation follow.

HBR: When you explain the challenge of rising economic inequality, where do you start? What’s the short version?

Furman: The share of income going to the top 1% has more than doubled since the late 1970s, and incomes have become more unequal across the income distribution — whether between the top 1% and the bottom 99%, the 90th percentile and the 50th, or the 50th and the 10th. I like to say that the rise in inequality is so large that there’s room for a lot of different explanations, all of which contribute to what has happened. What I’ve been pushing over the past couple of years is: In addition to traditional explanations, are there other factors that relate to the decline in competition?

What makes you think competition is declining?

There’s both microeconomic and macroeconomic evidence. On the micro level, most industries today have fewer players than before. Just think about hospitals or cellphone service providers or beer companies. Throughout our economy you see larger companies, older companies, and, in any given industry, fewer companies. Growth in international trade has been a counterweight — but only within the tradable sector. Most of our economy is not tradable, and so for most of our economy, international trade isn’t a factor.

On the macro level, companies’ rate of return on capital has stayed the same or risen, while the safe rate of return on bonds has fallen precipitously. If there were really vigorous competition, you wouldn’t see increases in return on invested capital. In addition, we see an increase in the share of national income going to capital — that is, to investors — rather than to wages. That income shift has been larger in industries that have seen bigger reductions in competition.

Jason Furman

At the same time, there’s less mobility of labor, the rates of new business formation and business destruction have fallen, and the dispersion of returns to companies has increased dramatically, meaning that some companies are doing really, really well and others much less so.

How does that lack of competition create income inequality?

Wages aren’t determined strictly by supply and demand; they also depend on institutional arrangements and bargaining power. And with greater industry concentration, the bargaining power of employers rises. If there are four hospitals in your town and you’re a nurse at one of them, you can threaten to leave and go work at another one as a way to get a raise. If there’s only one hospital, it’s a lot harder to advocate for a raise.

In his feature for this program, Nick Bloom suggests that pay gaps between companies result primarily from skilled employees’ clustering in high-paying firms. Does that seem plausible?

I think that’s an important part of it. But there are also wage differentials within industries, meaning that two workers with identical educations and skills are sometimes paid differently. People lucky enough to get on a rocket ship, to quote Google’s Eric Schmidt, are going to get paid a lot more. So what company you end up at matters a lot for how much you make. And the less competition there is, the bigger the differences in returns we’ll see across companies — and in wages between people who work for the most successful companies and those who work for less-successful ones, all else being equal.

Companies can be large for many reasons: It might be that they’re highly productive, or they benefit from strong network effects or high barriers to entry, or there’s some type of exclusionary conduct or market power at work. The reason I’m so worried about the decline in competition is that productivity growth has been quite low for the past several decades. A really important ingredient in productivity growth is weeding out less-productive firms and having more-productive firms thrive and succeed — and that process seems to have slowed down and is not working as well as it used to.

What would you like to see policy makers do to lessen inequality? And is there a role for companies to play?

I certainly think it’s the job of public policy to set a minimum wage, for example. It turns out that workers are more productive and companies have less turnover when you’re paying people more. The problem is that if you mandate a three-dollar increase in workers’ wage their productivity might go up by only $2.75 an hour, in which case it would have been rational for a company not to raise their wages. But because most of the cost is offset by higher productivity, the remaining 25-cent cost to companies might be relatively manageable — and may well be outweighed by the resulting social benefits. I don’t advise companies, but I suspect that in many cases, when firms treat their workers better, it ends up being profitable for them. I think there’s scope for more of that on the part of many companies. But I definitely think a lot of this is on policy makers.

Some rents, or excess profits, are inevitable, and so we want to make sure they’re divided better. We could do that by raising the minimum wage or by expanding labor unions. In cases where rents come from greater concentration and monopoly power, we want to address that with more-vigorous antitrust enforcement. In the United States, the courts have dramatically changed the way we think about and enforce antitrust rules over the past several decades. We used to scrutinize a merger in an industry going from six players to five. Now we barely look at it and automatically approve it.

There are other policy factors at work too. Requirements for occupational licenses make it harder for workers to move from job to job. Land-use restrictions make it more expensive to live in certain areas. Intellectual property rules have gotten stricter and stricter — and those are explicitly designed to reduce competition.

I think we owe it to ourselves to pursue all solutions — especially those with the potential to raise productivity and reduce inequality at the same time.The Big Idea